Credit Markets Frozen As Mortgage Market Melts Down - Commercial Bankruptcy Filings Rise
What started as a residential real estate crisis is causing a shortage of funds throughout the Capital Markets. The Federal Reserve is doing an effective job regulating risk free rates, but businesses don’t borrow at these rates. Today the Federal Funds Rate is 2.20%. Unfortunately this is not solving the problem of providing dollars to businesses. Capital providers are scared and sitting on the sidelines. Commercial bankruptcy filings are on the rise. In fact bankruptcy filings of all types are on the rise.
In order to induce lenders to invest in alternatives to the Treasury’s Risk Free Securities, Businesses pay a risk premium on borrowed funds; this Risk Premium is the difference between the Risk Free Rate and the actual rate paid. The Risk Premium is the compensation for lending to you instead of buying US Treasury Securities (Risk-Free). Commercial loan rates are not going down. The fact is lenders are scared; Risk Premiums are expanding and underwriting criteria is tightening up. A year ago when a middle market company needed to restructure financially it was much easier to recapitalize whether it was bank financing or selling securities. On top of that, you had plenty of private capital investors with money burning a hole in their pockets; commercial bankruptcy filings were at a low. The world is different today and the problem is at a point that the government is going to have to step up and provide risk capital. The downside of this is who knows what the unintended consequences of government intervention will be.
Remember during the last banking crisis during the first half of the 1990s things were not resolved until the government formed the Resolution Trust Corporation which took over (and subsequently liquidated) the portfolios of bankrupt lenders. If the holders of today’s pools of loans cannot efficiently liquidate problem assets the country is in for a painful digestion period that this analyst believes will last through 2010 perhaps through 2012.
We may have just seen the tip of an iceberg. News reports today included the revelation that credit default swaps (insurance against a bad receivable) on the debt of CIT Group (the largest independent commercial finance company in the U.S.) are more expensively priced than the Bear Stearns' swaps were just before the government arranged rescue of Bear Stearns.
In order to induce lenders to invest in alternatives to the Treasury’s Risk Free Securities, Businesses pay a risk premium on borrowed funds; this Risk Premium is the difference between the Risk Free Rate and the actual rate paid. The Risk Premium is the compensation for lending to you instead of buying US Treasury Securities (Risk-Free). Commercial loan rates are not going down. The fact is lenders are scared; Risk Premiums are expanding and underwriting criteria is tightening up. A year ago when a middle market company needed to restructure financially it was much easier to recapitalize whether it was bank financing or selling securities. On top of that, you had plenty of private capital investors with money burning a hole in their pockets; commercial bankruptcy filings were at a low. The world is different today and the problem is at a point that the government is going to have to step up and provide risk capital. The downside of this is who knows what the unintended consequences of government intervention will be.
Remember during the last banking crisis during the first half of the 1990s things were not resolved until the government formed the Resolution Trust Corporation which took over (and subsequently liquidated) the portfolios of bankrupt lenders. If the holders of today’s pools of loans cannot efficiently liquidate problem assets the country is in for a painful digestion period that this analyst believes will last through 2010 perhaps through 2012.
We may have just seen the tip of an iceberg. News reports today included the revelation that credit default swaps (insurance against a bad receivable) on the debt of CIT Group (the largest independent commercial finance company in the U.S.) are more expensively priced than the Bear Stearns' swaps were just before the government arranged rescue of Bear Stearns.